Should I use my savings to pay off my mortgage?

Is paying mortgage off in full a good idea?

It can be, but you may be charged a fee. You can pay your mortgage off early by making regular overpayments or using one-off lump sums.

• If you pay off your mortgage using lump sums your lender may charge you a fee - this is because if you're on a fixed rate mortgage then your lender will have already priced in the interest you pay when they gave you the mortgage deal.

• If you choose to make regular mortgage overpayments you'll also need to check with your lender whether you will be charged a fee.

• Most mortgage lenders will let you overpay up to 10% of the total amount owed in any one calendar year without charge. If you pay your mortgage off in full you will also have to check whether your lender charges an early mortgage redemption fee.

How should I pay off my mortgage early?

You'll need to:

• Check your mortgage terms and conditions to make sure overpayments are allowed

• Find out if overpayments now might entitle you to a mortgage holiday later, should you need it

You need to make it clear when you overpay whether you’d like to reduce your mortgage term or your monthly payouts. If you don’t, lenders might take that decision out of your hands leaving you with the less desirable outcome of the two.

Paying off an interest only mortgage early

If you have an interest only mortgage, remember that paying extra each month might not make any difference to your overall mortgage debt. 

If you want to use savings to reduce your overall mortgage debt by making overpayments, you'll need to either set money aside in a savings account or switch to a repayment mortgage. 

You should always, where possible, make sure you pay down both your mortgage interest and capital.

Is it worth paying off my mortgage early?

Making overpayments on your mortgage can help you reduce the amount of interest you pay overall and shorten your mortgage term. For example, if you had £135,000 left on a 25-year mortgage at a fixed rate of 5.25%, choosing to overpay by £100 a month (increasing your monthly payment from £809.98 to £909.98) could potentially cut around 5 years off your term and save you more than £25,000 in interest.

Whether overpaying is right for you will depend on your circumstances. A common consideration is how the interest on your mortgage compares with the returns on your savings. For example, if your mortgage rate is 2% but your savings are earning less than 1%, you may find overpayments provide a greater financial benefit.

Remember that it’s important to check whether your lender charges early repayment fees and to think about whether tying up money in your mortgage is the best use of your spare cash.

Consider your pension before paying off your mortgage

Remember that money saved into a pension is tax free, so before repaying your mortgage, you may want to consider putting more into your pension. 

Money can be taken from your pension at age 55 or 57 depending on your terms and conditions, so if your pension fund is earning 5% interest and therefore making more interest than your mortgage is costing then it may be worth saving more into a pension and using that money if you still owe money on your mortgage when you gain access to your pension. 

You can get advice on your pension options at the Government website MoneyHelper

Should I use my savings to pay off my mortgage?

It's a good option if you would normally put money into a savings account every month as, even though you may not see any immediate difference in your monthly payments, reducing the overall mortgage debt will bring down your payments the next time interest rates are recalculated.

Also overpaying now will more than likely give you a bit of leeway with the lender if you find it harder to meet regular monthly payments later.

• You will still need to hold back some savings - ideally at least six months worth of bills and everyday household and living expenses

• Work out how much extra you can pay each month towards your mortgage while keeping some savings aside for emergencies

How to pay off your mortgage using an offset mortgage

You can use an offset mortgage to pay your mortgage off early as they link your mortgage to your savings (and sometimes your current account). Instead of earning interest on your savings, that balance is offset against your mortgage debt.

You only pay interest on the difference, which can reduce your monthly payments or shorten your mortgage term.

For example, if you owe £200,000 on your mortgage but have £20,000 in savings in the linked account, you’ll only be charged interest on £180,000.

To pay off your mortgage faster with an offset mortgage, you can:

• Keep as much money as possible in your offset account - the higher your savings, the less interest you pay, and the quicker you can clear your mortgage.

• Use regular savings or lump sums - bonuses, inheritance, or even day-to-day savings all help reduce your interest charges.

• Maintain your monthly repayments at the original level - even if your payments fall due to the offset, continuing to pay the higher amount helps you chip away at the balance sooner.

Over time, these interest savings can significantly shorten your mortgage term and reduce the total amount you repay.

What happens when you pay off your mortgage?

Early mortgage repayment is an option if you have a large amount of savings, making paying your mortgage off in full possible. 

This means that you then own the property outright. Obviously, this option depends on how big your mortgage is, what terms and conditions apply and how much you have tucked away in savings.

You will need to check your terms and conditions carefully before considering this route as you may be charged redemption penalties (usually a percentage of the amount you pay off). It is also vital to balance the security you will get from owning your home outright with the need to retain some savings to offer a safety net if your finances take a turn for the worse.

• Check the terms and conditions of your mortgage to see if a redemption penalty would be incurred, and how much it would be

• Don't overstretch yourself; retain some savings for a rainy day

Paying off a mortgage early - what else you need to know

Using your savings to pay off mortgage and tax

Savings income is taxed, with ISAs being the exception, and while the money you spend on mortgage payments is not, there is a potential tax benefit associated with paying off your mortgage, as opposed to putting your money in a savings account or even a pension where you get your income tax refunded (it is put into the pension fund).

Additionally, there is an annual interest allowance of £1,000 (or £500 for higher rate taxpayers) meaning you need to earn more than that in interest from savings before tax is applied.

If you're unsure, check with an accountant to find out how your tax situation might be affected

Paying off debts before you pay off your mortgage

Before overpaying or paying off your mortgage, remember, even though the debt is usually very large, a mortgage is often one of the cheapest ways to borrow money so always aim to pay off high-interest debts first.

If you have a credit card, personal loan or even an overdraft, it is worth considering paying them off before you even think about reducing your mortgage payments. 

Credit or store cards in particular can often be the most expensive means of borrowing money, and personal loans are often more expensive than mortgages. Paying off expensive debts first will have a more immediate effect on your monthly finances.

As a general rule, the more expensive the debt in terms of interest rates, the greater the benefit you will get from paying it off quickly.

Making sure you pay off outstanding household bills first

Another option to consider is paying off any outstanding debts on your gas and electricity bills.  You don't pay interest on any outstanding balances, but your supplier will increase your monthly direct debit to ensure that any arrears are paid off over time - usually about 12 months. Clearing that balance will bring down your monthly payments, making you better off each month.

Advantages and disadvantages of paying off mortgage early

Advantages:

• Bigger financial gain - Mortgage interest is usually higher than savings interest. For example, £10,000 on a 5% mortgage costs £500 a year, while the same amount in a 1% savings account earns just £100 before tax.

• Tax advantage - Mortgage repayments aren’t taxable, but savings interest usually is (beyond your tax-free allowance). This means paying down debt typically gives a better after-tax return.

• Guaranteed saving - Overpaying your mortgage gives you a certain return (the interest you’re no longer paying), whereas savings interest rates can fluctuate.

• Offset or flexible mortgages reduce risk - With these, you can access overpayments later if you need them, combining the benefit of overpaying with the security of having funds available.

Disadvantages:

• Less access to cash - Once savings are used to pay off debt, you may struggle to cover unexpected costs. This could push you into expensive borrowing (e.g. 20% on a credit card or 40% on an overdraft).

• Savings could earn more in rare cases - If savings rates rise above your mortgage rate, keeping money in savings could be more profitable.

• Reduced flexibility - Without an offset or flexible mortgage, money you put toward your mortgage is locked in and can’t be withdrawn.